….but affirmative duty to take #ESG into account may be lower risk at this point (see Dudenheoffer) than allegations that incorporating #ESG in plan investments violated duties of prudence or did not comply with plan documents. @GregIacurci https://t.co/k9VEA2kO49
— Fiduciary Governance Group (@FidGovGroup) November 18, 2019
State Street Global Advisors (SSgA) recently released a research report entitled, “Into the Mainstream – ESG at the Tipping Point.“ It begins with a salient point: “ESG may well be becoming a mainstream trend, but every institutional investor – from pension funds to endowments to sovereign wealth funds – faces a unique mix of forces pushing them towards, or pulling them away from, ESG investing.” Indeed, asset owners and their managers are in fact subject to distinct standards of care, with ERISA’s fiduciary duties being the ultimate. In reviewing this report of global institutional investors’ reasons for addressing environmental, social and/or governance (ESG) factors in their investment decisions, and their reasons for not doing so, I considered the implications for ERISA fiduciaries, as “pension funds” were one of the institutional investors surveyed (along with endowments, charities, sovereign wealth funds and others). Consider also some of my prior analysis on the interplay of fiduciary duties under ERISA and ESG issues.
Here are the key takeaways:
- Fiduciary Duty: A Hurdle or Affirmative Duty to Incorporate ESG? A longstanding, significant obstacle to adoption of ESG by ERISA plans was whether it could be done in a manner consistent with ERISA’s fiduciary duties. The duty of prudence (Section 404(a)(1)(B)) has been the primary area of concern under an ERISA/ESG analysis, but duty of loyalty (Section 404(a)(1)(A)) and diversification (Section 404(a)(1)(C)) issues may also arise depending on the circumstances. Interestingly, the SSgA findings indicate that 46% of those surveyed viewed fiduciary duty as a push factor – i.e., an affirmative duty. If we drill down, the % of respondents who cited fiduciary duty as a lead push factor was highest in North America. If we drill down further, we see that, 41% of pension funds view ESG as a fiduciary duty. So, while pension funds seem less likely to view ESG as an affirmative fiduciary duty relative to other institutional investors, the fact that 41% do is notable. Again, this picks up pension funds globally and appears to cover private (i.e., ERISA) and public (i.e., governmental) plans.
- Risk Mitigation or Opportunity? The results also show that ESG risk mitigation is, at this point, (much) more of a basis/push factor to incorporate ESG factors into an investment decision than outperformance reasons (in North America, 42% (of all respondents – not just plans) cited risk mitigation vs. 1% who cited ESG as a way to generate higher returns). Various other studies make the point that ESG can present both mitigation and return opportunities, so it is interesting that institutional investors have gravitated toward mitigation rather than return. Perhaps lack of standardized disclosures and metrics is a reason, but it would seem that would affect both downside risk and return on any given investment. Perhaps another reason is that the outperformance takes longer to materialize. The DOL has reiterated that integration is examined under the regular prudence test and not the heightened tie-breaker test.
- Obstacles: A continuing theme, now picked up by this new SSgA report, is that the lack of standardized and transparent ESG data remains a primary obstacle to adoption (e.g., inconsistent scoring across the various providers). SSgA, in this report and over time, has helpfully examined the correlations of the major data providers in terms of a specific company’s ESG coverage. In one example, the ratings of companies by two prominent providers had a correlation of (only) .53. The lack of expertise in ESG was also cited as a top reason for not incorporating ESG factors – a valid reason for not making a particular investment under ERISA (fiduciaries are not expected to be all-knowing, but are expected to seek outside expertise when doing so would be prudent). Perhaps this explains why more and more ESG-related questions are showing up on questionnaires sent to investment managers.
- Governance: Respondents reported better measurement of governance (G) factors than environmental (E) or social (S) factors. For ERISA fiduciaries using integration, an analysis/documentation of how the respective E, S and/or G factor affects performance is important under DOL guidance. It is also important for investment managers and appointing fiduciaries to be clear on whether one or more E,S or G factors will be incorporated for any particular mandate, and to confirm that doing so would be in accordance with plan documents.
#ESG has become an issue that most plan fiduciaries have at least considered addressing. ERISA and governmental plan fiduciaries still working through analysis in terms of how to account for ESG risks/opportunities while satisfying fid. duties….
— Fiduciary Governance Group (@FidGovGroup) November 12, 2019
The SEC’s Division of Investment Management issued on Friday Frequently Asked Questions Regarding Disclosure of Certain Financial Conflicts Related to Investment Adviser Compensation. The FAQ discusses certain compensation arrangements and related disclosure obligations arising from both the investment adviser’s fiduciary duty and Form ADV.
Fiduciary Governance Group Co-Chair George Michael Gerstein will be a panelist at the upcoming National Society of Compliance Professionals’ (NSCP) National Conference in Baltimore. His panel, ERISA: Now and Into the Future, will cover a wide range of key topics, including a litigation update, rollovers and ESG, among others. The conference takes place on October 21-23, with additional registration information available.
In just a few days, the Department of Labor will be set to satisfy its obligations under the President’s April Executive Order by “complet[ing] a review of existing Department of Labor guidance on the fiduciary responsibilities for proxy voting to determine whether any such guidance should be rescinded, replaced, or modified to ensure consistency with current law and policies that promote long-term growth and maximize return on ERISA plan assets.” In an op-ed I wrote for Pensions & Investments, I put the EO into context and highlighted some possible paths the DOL could take. As we await any guidance, I would like to highlight this point that I made several months ago:
“…it is possible the DOL could adhere to the executive order by issuing new guidance that raises the perceived costs of proxy voting and other forms of shareholder engagement and/or demands a more rigorous analysis on the part of fiduciaries that such engagement is “clearly connected to” shareholder value. Any new test could not be so onerous as to make divestment preferable to engagement, as that would seem to undermine the executive order’s very purpose.”
We will, of course, conduct a full analysis of new DOL guidance, which we will post to this blog.